Common questions about market volatility answered for investors

As we try to navigate potential trade friction, Brexit, increasing tensions in the Eurozone, and hawkish monetary policy from Central Banks, threats to the global economy have been reflected in a recent downgrade to growth expectations by the IMF.

It’s important to remember after periods of such low volatility, that this dynamic is a normal part of the financial markets and can be managed in line with your investor profile. But we know the impact volatility has on your portfolio can be unnerving, especially when you’re working towards your financial goals.

That’s why we’ve pulled together this handy guide of the most common questions Moneyfarm investors ask us during market volatility, answered by our Head of UK Investment Consultants Will Hedden.

What is volatility?

Volatility might be one of the most basic financial concepts, but it’s often misunderstood. Fluctuations in the price of an investment is important for growth, and a crucial dynamic of the financial markets.

Market volatility measures how much an asset price changes over time. High volatility means the price of an asset is likely to change dramatically over a short time frame, whilst low volatility indicates an asset’s price will be relatively stable.

Calculated in percentage points, you can measure volatility either through the standard deviation, or by comparing the volatility of an asset’s returns against the relevant benchmark – known as its beta.

What causes market volatility?

As volatility is the measurement of how much an asset price changes over time, the drivers are the factors that influence investor decision-making to buy and sell an asset.

Markets can be particularly volatile when something unexpected happens or during periods of uncertainty. For example, the shock Brexit vote in the 2016 EU referendum caused a sharp fall in the price of sterling. Sterling is still very exposed to the Brexit debate and any noise coming from the negotiation room can cause a sharp reaction on the currency market.

Currently there are some big themes influencing financial markets; Brexit, interest rates, global trade frictions, economic growth and the EU. If you ever want to discuss the performance of your portfolio, book a call with your Investment Consultant who will be happy to discuss the market backdrop and outlook.

Should the investment team quickly change the assets in my portfolio to avoid volatility?

Timing the market is a difficult thing to get right. You need to identify the exact moment to buy and sell an asset to ensure you get the most profit you can. Nobody has a crystal ball, although to consistently time the market correctly you could probably do with one.

Volatility can make investors feel forced into a corner, and trigger a reaction that goes against your original strategy, like selling too early trying to avoid any big losses.

Knee-jerk reactions to market volatility can do more harm than good to the value of your portfolio. It’s common for asset prices to recover quickly after a temporary dip, which can leave you selling an asset for less than you bought it for.

Before you invest in an asset, you need to research its value and assess how much more you believe can be unlocked within your timeframe. If you believe in the value of your investment, short-term fluctuations in its price shouldn’t change your sentiment forcing you to sell, if anything you should be encouraged to buy.

Of course, sometimes big events can skew these fundamentals and then it’s time to make a well-thought change to the investments in your portfolio. But this should be well-researched action to a fundamental change, not a reaction to market performance.

Does high volatility lead to a rebalance?

At Moneyfarm, volatility itself doesn’t trigger the rebalancing process. Our Asset Allocation team monitors the markets and the global backdrop closely to understand how the geopolitical and macroeconomic scenario can affect our portfolios.

Although the latest rebalance coincides with a recent bout of volatility, our decisions were based on changing fundamentals, not movements on the market.

The Asset Allocation team always have the level of risk you are comfortable with in mind when monitoring portfolio performance. To understand the level of risk, the team back-test the volatility over different historical periods for comparison and make necessary adjustments.

Is market volatility good/bad for my investments?

To make a profit on an investment, you need to sell an asset for higher than you bought it. Volatility provides you with the market dynamics to do this, if you keep to your strategy.

Of course, volatility can be bad for your investments, although it’s important to remember that if your portfolio is down, you haven’t physically lost any money until you hit the sell/disinvest button.

This is why it’s important you invest in the way that reflects your financial habits, priorities and risk appetite. If you’re happy to take on risk as you have a long-term time horizon, you can invest in riskier assets with the hope that you’ll benefit from greater growth over the long run.

If you have a shorter time horizon, it’s better that you reflect this in your portfolio’s risk level. Although you will restrict your growth potential, you’ll also limit downside risk.

Understanding your risk appetite and how to reflect this within the investments in your portfolio can be a difficult thing to get right. At Moneyfarm we do it for you with our investment advice.

By completing our investor profile questionnaire we match you with an investor profile that outlines your risk appetite. We then pair you with an investment portfolio that’s specifically built and managed by our investment team to reflect your investor profile. These portfolios are then regularly rebalanced to make sure they continue to reflect you for as long as you invest with us, free of charge.

Should I take my money out or invest more during market volatility?

Although volatility looks bad on your portfolio, you haven’t physically lost any money until you hit the sell/disinvest button, as explained above. Once you disinvest, you agree to sell your asset for a lower price than you bought it for.

Trying to avoid losses by timing the market to sell your investments can be a dangerous game to play that leaves you financially worse off. Common performance patterns show stock prices recovering after falling in value, which can mean you sell it for less than you bought it for.

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You could see weaker prices as a buying opportunity and decide to invest more. By getting the asset at a better value you could maximise your profit. As volatility is a measure of price movements both up and down, this strategy involves timing the market again, which can be difficult to do in times of volatility.

If you’ve set up a direct debit, you can carry on as normal. By investing little and often, you can smooth out the price you pay for an asset over time, reducing it during periods of volatility, helping you maximise your return. By setting up a regular investment, you can ignore market noise. Whilst it can often feel like many things on the financial markets are out of your control, removing bias is something you can influence.

To set-up a direct debit, log-in to your account and go to ‘Add Money’ or you can book a call with an Investment Consultant here.

How is my portfolio designed to mitigate market volatility?

Moneyfarm provides you with investment advice so you know you’re investing in a portfolio that reflects you and your risk appetite. Your portfolio is built around your investor profile, so riskier portfolios have a higher exposure to equities, for example.

Our Asset Allocation team will work to manage the risk in your portfolios through diversification. Investing in a broad range of investments, assets classes and geographies might seem simple enough, but getting the right mix to help you reach your goals can be difficult.

In a diversified portfolio, any fall in one asset class should be offset by better performance in another. Whilst evidence suggests that it’s difficult for active stock pickers to consistently outperform the market over time, a diversified portfolio is typically better insulated against downside risk.

At Moneyfarm, we believe a diversified portfolio is likely to create the best outcomes for our investors and our portfolios typically hold seven-14 exchange traded funds (ETFs), diversified across geographies and asset classes.

Should I change my portfolio’s risk level?

Your investor profile and risk level is based on you, not the external environment. By building your portfolio to reflect your appetite for risk, you can help mitigate external risks better than having a reactionary investment strategy.

We do know that circumstances change and your tolerance for risk may increase or decrease over time. That’s why our ongoing suitability algorithms run once a month or whenever there are any big changes to your portfolio. If we think you need to change we will suggest this to you when you log-in.

How is the performance of my portfolio calculated?

Your portfolio performance is calculated using a money-weighted calculation. We believe this gives you a more accurate picture of the true return you received as an individual, accounting for your individual cash flows – these could be dividends, account top-ups or disinvestments.

If you were to invest – or disinvest – an amount from your portfolio, this impacts the performance number. Technically speaking, this measure of performance corresponds to a well-known concept in finance called the internal rate of return (IRR). We compute the IRR of your portfolio every day.

There are a number of different ways to calculate performance, and we’re looking to show multiple ways in the future. This may include Time Weighted Performance.

If you have any questions about the way we calculate the performance of your investments, book a call with an Investment Consultant today.

What’s a correction?

A market correction is a 10% decrease in the price of an asset, that seemingly works to fix an overvaluation. Whilst a double-digit drop in the value of a portfolio isn’t pretty in the short-term, corrections are generally seen as good for the market and investors.

Market corrections are seen as good opportunities for seasoned investors to pick up high value assets at discounted prices, and can be a welcome wake-up call for more novice investors to ensure their portfolio reflects their risk appetite.

Common on the financial markets, US markets experienced 38 corrections between 1980 and 2018, according to Investopedia.

What are bull and bear markets?

The bull and bear are important elements of the financial markets. Bull and bear markets coincide with the four stages of the economic cycle: expansion and peak, followed by contraction and trough.

A bull market, or bullish conditions, describe a market where prices are rising or expected to rise. It symbolises financial optimism, investor confidence and prosperity.

The beginning of a bull market can generally be seen as an indicator of economic expansion, as perception on the economic outlook drives stock prices.

The bear market, or bearish conditions, describe a market where prices are falling. Widespread pessimism can whip up negative sentiment, which can become self-fulfilling. Bear markets can be seen as precursors of economic contraction.

Bearish people may want to sell their investments or take short positions in the market. Figures can vary, but it’s widely considered that a downturn of 20% or more over at least two months signals the beginning of a bear market.

It’s important to note that this 20% is just a threshold we’ve imposed to define market movements. When a market loses 20%, nothing particular special happens. In fact, markets can bob in and out of a bear market for some time.

What strategy should I take in market volatility?

Market volatility can be unnerving over the short-term, but it’s important you stick to your long-term investment strategy to avoid any potentially painful knee-jerk reactions trying to escape to cash.

Below are five tips to ensure that even in periods of volatility you’re in the best position to reach your goals over the long-term.

Invest in the right way for you – Get cost-efficient investment advice to ensure your portfolio reflects your financial background, personality and risk appetite.

Understand what you’re investing in – To ensure you don’t react to market movements but the underlying value of your investment, know an asset in inside-out before you invest in it. Understand how much it’s valued now, how much you expect it to grow in your time horizon, and know the risks. This takes a lot of work to do yourself, which is why many prefer the experts to do it on their behalf through discretionary management.

Diversification – Manage specific risks by diversifying your investments across assets, sectors and geographies. Diversification can be a difficult thing to get right yourself, but you hope to offset any losses in your portfolio with gains made from other assets, smoothing out performance.

Invest for the long-term – Many investors look for the elusive edge on the financial markets, when all they really need is time. By adopting a long-term approach, investors can ignore any short-term noise and look to benefit from long-term positive trends.

Set-up a direct debit – Invest little and often to benefit from pound cost averaging during volatility. By averaging out the cost you pay for an asset over time, you can lower the price and maximise your profit.

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